A Tribute to the Thoughts of Another and his Friend"Everyone knows where we have been. Let's see where we are going!" -Another

Wednesday, September 8, 2010

Just Another Hyperinflation Post - Part 1

Hyperinflation talk has come to the forefront once again (thanks to a few recent articles), and being my #2 (of 2) topic here at FOFOA, I have a small but relevant offering for you. This is a compilation of a few posts from a recent discussion I had on another forum. The subject was hyperinflation and the deflationists that emphatically say it is impossible here. And the question was asked, What do these deflationists mean by deflation? Monetary deflation? Price deflation? Asset deflation? And so on. "What is deflation?" was the primary question.

Always looking for a fresh angle, which I like to do, I thought a much more interesting question was, "What is a deflationist?" The term deflationist is one I have been using regularly on my blog for two years now. And it is a term that I appropriated, definition and all, from FOA's writings a decade ago. Here are a couple of his "deflationist quotes" to kick off this post…

"Somewhere in the 1970s era I was exposed to the thinking of several different deflationists. It seemed that all of their conclusions came to the same end: that dollar deflation would rule the day, no matter what. Mind you now,,,,,, most of them were split on the finer points of the issue, but for all of them; Deflation was always the final outcome."

And of course his most famous one…

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"

What is a Deflationist?

What is a deflationist? It is one who looks very closely at the present structure of everything, the laws, the rules, the regulations, what is supposed to happen, who should fail, etc… but ignores the political (collective) will that backs it all up. The same political will that always changes the rules to suit its needs as surely as the sun rises. And it is this political will that makes dollar hyperinflation a certainty this time around.

It is beyond frustrating to watch all the bailouts of banks at a time like this. They should be allowed to fail! Right? But this ugly sight is only a symptom of the real problem. And it was never even a choice. As FOA warned 12 years ago, these bailouts were always baked into the cake. They are a mandatory function of the political will that backs the entire system. This is the main element that all of the deflationists miss.

Unlike FOA, the deflationists never saw the bailouts or the QE coming, and they refuse to believe that it will keep on coming as long as ANYTHING keeps failing. States, pension funds, large companies, foreign entities, whatever. It's all gonna be papered over. And the choice to stop bidding on dollars rests solely in the hands of those with large stockpiles of physical gold.

Once they stop bidding for dollars with their gold, the goose is cooked. (See: " Dollars Bidding for Gold? Or Gold Bidding for Dollars?" here.)

In a recent interview over a couple beers, one self-proclaimed deflationist said this:

The hyperinflation case, if one wants to make one, and I'll make one right now, is congress sends everyone $60,000, that would probably do it, but is congress likely to do that? …All this talk about the Fed being able to drop money out of helicopters, that's not the way it works.

First of all I would like to clear up probably the most common misconception about hyperinflation. What most people believe is that massive printing of base money (new cash) leads to hyperinflation. No, it's the other way around. Hyperinflation leads to the massive printing of base money (new cash).

Hyperinflation, in most people minds, conjures images of trillion dollar Zimbabwe notes. But this image is simply the government's reflexive response to the onset of hyperinflation, which is actually the loss of confidence in the currency. First comes the loss of confidence (hyperinflation), then, and only then, comes the massive printing to keep the government and its obligations afloat.

Can you see that the above deflationist is basing his view of hyperinflation on this misconception? We don't need the helicopter drop to spark hyperinflation. Zimbabwe didn't have billion dollar notes when hyperinflation started. They only had Z$100 notes just like the US. The million and billion dollar notes followed the onset of confidence collapse as the government printed to survive.

Another consideration is that sometimes there is a "deflationary head-fake" right before the onset of hyperinflation as the private bank credit money disappears...

With these charts I am not saying it always looks exactly the same. I am only observing that the common deflationary metrics can fall while credit collapses, but then be immediately followed by a confidence collapse in the currency itself. Deflationists don't see this because they are viewing the economy as if it were a machine. And machines don't flip 180 degrees on a dime like this.

I tend to agree with 99% of what the deflationists write. For the most part they are masters at analyzing the minutiae and then painting it into a grand macro picture. I like the Kondratieff cycles and I agree we are in the winter cycle. In fact, almost everything most deflationists describe will probably happen, in my view.

But they all miss the hyperinflation that is coming. And they miss it because they don't understand how perfectly it fits with a deflationary collapse. In fact, they argue vehemently against it the same as they argue against inflation, which is how I know they don't understand hyperinflation. And they miss it because they are so meticulous in their observations and calculations that they can't see that the collective will always changes the rules when things get really painful. The political will (which is the same as the collective will in my lexicon) always does whatever will lessen the immediate pain, even if it will most certainly cause greater pain later. This is the part that is as reliable as the sun rising.

Here's the main thing: the deflationists make all their calculations in dollar-denominated terms. They can't help it. It's as natural and automatic as breathing air to their Western minds. But this small flaw in the numéraire of their calculations leads them to funny conclusions about the future value of dollars. For one thing, the coming deflation must be in dollar-denominated terms, they believe. But this is impossible today. Because we have a purely symbolic currency, a dollar-denominated deflation is impossible... because of the political will I mentioned above!

Yes, we will have a grand deflation... denominated in GOLD! It will be brought on by all the same factors the deflationists correctly recognize. The failure of debt, the winter cycle, etc... And it will look the same as they imagine. Depression, unemployment, falling prices (when priced in GOLD), black and white pictures, etc...

You see, hyperinflation is exactly like deflation. The only thing hyperinflation has in common with inflation is part of its name. Other than that it looks just like a deflationary depression. In fact, it IS a deflationary depression, with a different numéraire! Just look at Zimbabwe a couple years ago. Other than the fancy wheelbarrows, it looked just like a depression.

Now you might ask, "What's the difference between a deflation denominated in gold versus dollars?" Well, there's a huge difference to both the debtors and the savers. In a dollar deflation the debtors suffocate but in a gold deflation they find a bit of relief from their dollar-denominated debts. And for the savers, the big difference is in the choice of what to save your wealth in. This is what makes the deflationists so dangerous to savers.

The deflationist equation, if properly applied, always leads to the conclusion that the best things to save are cash and Treasuries. And some (not all) deflationists even apply their formula to gold (because they believe it will behave like a commodity) and conclude it must crash to around $200/oz during their deflation. So they warn their readers to stay away from gold.

Can you see how one little flaw in the numéraire can make an analyst very dangerous to your bottom line?

Here is the way the deflationist views the world. Think of all the debt as a large balloon. As it is expanding the balloon is being inflated. Today that balloon is deflating and no matter what the Fed does, it can't seem to reflate that balloon. And the deflationist concludes that as long as that balloon is deflating, not inflating, we MUST have deflation, and the value of a dollar MUST rise.

But here is the correct way to picture it. There are actually TWO balloons side by side. These two balloons are the two sides of the global balance sheet. One belongs to the debtor and the other to the saver.

If we think about "global debt" as "global liabilities," then there must be the equal and opposite "global assets." Simple balance sheet math. The liabilities are failing because collateral values are falling and debtors are defaulting. As FOA said, "As debt defaults, fiat is destroyed." Or another way to say is, "As debt defaults, fiat savings are destroyed."

But what is actually happening is the assets are being papered over with fresh base money. FOA: "hyperinflation is the process of saving debt at all costs, even buying it outright for cash." Or said another way, "hyperinflation is the process of saving debt-backed assets (MBS's etc..) at all costs, even buying them outright for cash."

These two balloons are a metaphor for the global balance sheet with an "airy" elastic bubble-like quality since we are talking about "inflation" and "deflation." They are a way to visualize the two sides of the balance sheet inflating and deflating in tandem like they're supposed to, and then separately as the debt-backed assets are saved at the cost of destroying the transactional currency.

In the beginning, as the debt balloon expands so does the savings balloon. And this second balloon expanding represents credibility inflation (see my last post). Credibility inflation is the confidence the savers have in saving the debtor's debt. And this is what enabled the debt bubble to grow so large in the first place. And in a circular fashion, the debt also allowed the savings bubble to grow so big, bigger even than the underlying world of real things.

So in the early stage we have a feedback loop of credibility inflation. Debt creation inflates the amount of "stored wealth" and this "stored wealth" (stored as someone else's debt) enables more and easier debt creation. Subprime loans and MBS's are a perfect example of this kind of a feedback loop. The invention of Subprime fed the MBS phenomenon, and the MBS phenomenon enabled (and demanded) the invention of Subprime. And today's credit contraction is a sure sign that the feedback loop is no longer functioning. Banks don't like to extend credit unless they can immediately sell the resulting hot potato of "stored wealth" to a pension fund or some other sucker.

Anyway, the future hyperinflation fuel is stored in the savings balloon during this period of credibility inflation. (Again, see my last post.) That's why we see very little price inflation during this stage. And when the debt starts to fail, so does the credibility of paper debt to the savers. The Fed is trying desperately to restart the credibility feedback loop that will reflate the deflating debtor balloon. That, of course, is impossible at this point; an observation the deflationists intuitively make correctly, even though they are only looking at one of the balloons.

So as the credibility of debt paper as a savings instrument fails in the mind of the savers, that hyperinflation fuel stored in the savers' balloon turns into real price inflation as it scrambles to be spent. Remember that this savings balloon has grown larger than the underlying world of real things!

Now here is where the deflationist would stop me and say, "Wait a minute. Both of your balloons are deflating at the same rate so your 'savings' could never escape." But this is also where the political (collective) will comes into play. It will NOT let that savers' balloon deflate. The Fed is helpless against the debtors' balloon and the credit/debt feedback loop, but it is most certainly NOT helpless against the savers' balloon.

The Fed has the power to keep the savers' balloon 100% full if it wants to, and the political will to fully back that action. It simply buys those deflating MBS's (etc..) at full price ("dumping them on your front lawn! (smile)") and suddenly the air in the savings balloon has been replaced with non-elastic fresh cash. This process is already well underway… and IT IS the trigger for hyperinflation.

Remember, first comes hyperinflation, then, and only then, comes the massive printing as the Fed tries desperately to keep the government functioning. So don't look for massive printing to see hyperinflation coming. Look for the monetization of bad debt and the first signs of real price inflation, even in the face of apparently deflationary forces.

A note: Gold could sop up most of the hyperinflation presently stored in the savers balloon without destroying the real economy (see my old post Freegold is like a Giant Sponge). But it is the US Govt. that will make sure this becomes a real Weimar-style hyperinflation when it forces the Fed to monetize any and all US debt. And as dollar confidence continues to fall, that's when the debt must go exponential just to purchase the same amount of real goods for the government. One month the debt will be a trillion, the next month it will be a quadrillion just to buy the same stuff as the previous month. How long will this last? Less than 6 months is my guess.

Another Angle

There is another important angle to this story that the deflationists all miss. You may have caught it if you thought to yourself, "Well, even if the Fed keeps the savers balloon 100% full while the debtors balloon deflates, that's only half the money supply as before." This is exactly how the deflationists think. They see no difference between the two.

But there is a fundamental difference between the kind of money that fills the debtors balloon (credit money or balance sheet money) and the kind the Fed is using to prop up the savers balloon (monetary base). This is a critical difference that deflationists can't seem to wrap their heads around (and I'm not sure why).

You see credit money is tied to the functioning of the economy and base money is not. As the debtors balloon deflates, so does the functioning economy, and so does the real world of goods that backs the money supply. Base money does not contract along with the economy like credit money does. And base money is the fuel in all hyperinflations while credit money vanishes!

As the economy along with the debtors balloon contracts and the confidence of the savers wanes, the previous driving force of greed switches to the much more powerful force of fear. And "switch" is a great word in this case, because this transition can hit the entire planet all at once as fast as flipping a "light switch." It's called a panic.

When it does, that's when the velocity of the monetary base takes off. And as I have pointed out before, velocity has the same exact effect on the value of a dollar as an increase in the money supply. (See my "sea shell island" analogy here.) If the velocity jumps from fear, base money can chase scarce goods with the same disastrous effect as an exponential increase in the money supply, even before that actually occurs.

Jim Powell has pointed out that the tens of millions of people who are still working — and that's 91.5% of the workforce — have received a huge pay raise, because prices of houses, cars, refrigerators and a lot of other things, have been cut drastically. The buying power of their wages has soared!

And, it's the best kind of pay raise, because they didn't need to work any harder to get it, and it's not taxed.

This is a huge windfall. It's probably the biggest, most widely shared windfall in all of world history.

So why aren't these tens of millions of people out celebrating? They should be delirious with joy. Why aren't we seeing dancing in the streets?

Because people are scared and afraid to spend the money. And that brings us to what economists call velocity.

As this war was developing during the 1990s, I repeatedly warned that it was likely to bring a dollar crisis, and advised my readers to always have part of their savings diversified into non-dollar assets such as Swiss francs, New Zealand dollars, gold, silver, platinum, oil, and other raw materials.

Incidentally, in March on our web site, I ran a special bulletin telling my readers that I think there is an 85% probability the bottom in non-dollar assets has occurred, or is occurring, and I think those investment suggestions are now as solid as they were ten years ago.

A major reason is velocity. As far as I know, my Early Warning Report is the only publication that says much about it.

I think velocity has become the key driver in the entire world-wide economic crisis, so here is a quick explanation of it.

Money responds to the law of supply and demand just as everything else does.

If people do not want a particular currency — let's say the British pound — then the value of a pound will fall.

Sellers will demand more pounds in trade for their goods or services, and prices in Britain will rise, even if there has been no change in the supply of pounds.

On the other hand, if the demand for pounds rises, the value will rise and prices will fall even if there has been no change in the supply of the currency.

Velocity is the speed at which money changes hands. When demand for the money is high, money changes hands more slowly, and velocity is low.

When demand for the money is low, velocity is high.

A key point is that velocity and money supply can act as substitutes for each other. A 10% rise in velocity has the same effect as a 10% rise in money supply.

The biggest problem with velocity and money demand is they can turn 180 degrees overnight. If people trust the currency, and suddenly perceive some kind of big threat to their futures, money demand can shoot up.

That's exactly what happened last year. The supply of dollars certainly did not go down, but when the real estate crash happened, people became so frightened they were afraid to let go of their dollars.

Within a few days, money demand shot up, people stopped spending and held onto their dollars, and this had the same effect as an instantaneous deflation of the money supply.

If you don't spend your money, that's the same thing as taking it out of circulation.

This can instantly cause the equivalent of a sharp deflation of the money supply by 10 or 20 percent, or more.

That's what happened in the Great Depression. The Fed was inflating. In 1932, the money supply[1] was $20 billion, and by 1940 it was $38 billion. But fear was so great that velocity was falling faster than money supply was rising.

This is why Franklin Roosevelt said in his first inaugural speech, "The only thing we have to fear is fear itself." People were afraid to spend their money, as they are now, and velocity was falling, which has the same effect as deflation, because if you don't spend your money, it's not in circulation.

So, speaking economically, I think that is where we are now. Changes in money demand and velocity are running everything.

And, my key point is, it's all controlled by emotions. By fear.

What are you more afraid of? The dollar becoming worthless? Or losing your job and running out of dollars?

The whole world is constantly shifting back and forth between those two fears, so money demand bounces up and down like a yo-yo, and velocity — the speed at which the money changes hands — does, too.

These wild shifts in money demand and velocity have the same effect as massive, instantaneous shifts up and down in money supply. It's like we're having a huge inflation, then a deflation, every few hours — because our fears change every few hours — because the politicians have all this arbitrary power and we don't know what they're going to do to us!

Now, do you see why it is so important to see the economy not as a machine but as an ecology. Machines don't feel, they don't have fear, or joy, or optimism.

But people, biological organisms, do have feelings. They do fear, and their fears can change instantaneously.

The human ecology, especially these days, is driven very largely by emotions.

How are the politicians and bureaucrats who are playing God ever going to control, or fine tune, or repair, or speed up or slow down, our emotions?

This is an excellent description of what the deflationists see, and also why they don't see the rest of the big picture. They view the monetary world as a machine rather than a human ecology. They underestimate the will of the "politicians and bureaucrats who are playing God." And they also underestimate the power of fear and monetary velocity.

And now that you have a little bit of understanding about the difference between economically-tied credit money and base money (cash or its equivalent), as well as the power of fear and velocity, I want you to notice that the hyperinflations of the past have all played out with base money, not credit money, at the helm.

This is where all those "excess reserves held at the Fed" become very dangerous. You see, those are monetary base reserves, not credit money. They may not be physical cash yet, but they are contractual obligations of the Fed to print actual cash. And if velocity picks up in a panic, that's exactly what the Fed will have to do in order to keep the banking system from collapsing. Deflationists think this is a choice the Fed will have to make, but it is not.

It is already happening to a smaller degree with the Friday bank failures. Ever since the FDIC ran out of "reserves," every failed bank has been propped up with more fresh base money. "Saving the savers' deposits!" Converting them from credit money into base money in whatever amount exceeds the failed bank's marked-to-market assets.

So there is already enough fuel in the system to feed the fire when it starts.

And when it starts, that is when prices start to rise... price hyperinflation. And as prices rise, the government will need more money to pay for the same amount of "governing" in each successive cycle (monthly). This is when the monetary hyperinflation takes over and gives the price hyperinflation its HYPER boost.

Deflationists often refer to "foreign-denominated debt" as the cause of hyperinflation and also as their ace-in-the-hole reason why the dollar can never experience a Weimar-style hyperinflation. But this is a complete red-herring. The foreign debt was not the cause of the confidence collapse. It was only the fuel that forced the government printing... the second stage boost in hyperinflation. In our case we have a different kind of fuel, the most over-sized federal government the world has ever known!

And as the dollar confidence fails, those famous "$100T unfunded obligations" will have the exact same effect as Weimar's "foreign denominated debt." Think it through! As general price levels go exponential so do government obligations!

Let’s read FOA’s famous quote again:

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"

And here's one more for the road:

"Yes, even my untrained eye can see that we are approaching the end of a currency life cycle. When all of the debt can no longer be rolled over, the world does not end. It moves on, into another fresh system! This current contraction will not create a deflation as it did in the past. It will involve a rollover that will balance the losses for some with the gains for others. Will your wealth balance in this event? FOA"

51 comments:

"Remember, first comes hyperinflation, then, and only then, comes the massive printing as the Fed tries desperately to keep the government functioning. So don't look for massive printing to see hyperinflation coming. Look for the monetization of bad debt and the first signs of real price inflation, even in the face of apparently deflationary forces.

IMO you can tick off both of these indicators. The "monetization of bad debt" has been going on for two years, starting with TARP.

The reduction in weight/volume/portions in FMCG (consumer staples), while prices remain the same, has been gathering pace over the same timeframe. Recent reports of demand for higher wages in China and Walmart raising prices could also be a warning.

I would throw in a third sign to watch for. An acceleration in the reduction of the USE of the US$ in bi-lateral trade (and by default world trade).

That is a significant article alright. As Ender pointed out a high usage demand is where a currency (in this case the USD) is able "... to expand the base from which they can gather tax through inflation."Usage demand is diminishing and there is little they can do about it. And who is diminishing that demand... not the same crowd who are buying up all the physical gold they can get their hands on is it?Coincidence?

It is most revealing to read FOA's comments:"Somewhere in the 1970s era I was exposed to the thinking of several different deflationists..."

and

"...hyperinflation is the process of saving debt at all costs, even buying it outright for cash."

FOA had already had 20+ years of considering this knowledge before he wrote those words a decade ago. This fiery end to debt-based paper was recognized by those from whom he learned even further back. To think that plans were not made to cope with, and even take advantage of this eventual collapse is naive, at best.

Thus was conceived the Euro, a currency which would find strength in this weakness; strength in its floating gold reserves, free from national interests, growing in usage demand.

Wonderful post Fofoa. We should call you Babe Ruth because you just keep on knocking them out of the park.

I also like the way you discuss the coming panic, which is what I want to avoid and why I have been buying PM's for a while. I don't want to be hanging out at the safeway waiting desperately for the food distribution truck to arrive, and I don't want to be desperately trying to salvage what is left of my rapidly dwindling paper wealth from a hyper-inflationary inferno.

A couple of threads back you said that the Swiss Frank (might?) be the only fiat to survive. I would love to hear your thoughts on that score.

@Angel Eyes, Do you think that EU political hacks will be any less desperate to save the collapsing debtors than the US political hacks? Just look at the evidence, the EU is monetizing hundreds of billions in sovereign debt and the ECB has already thrown it's charter out the window in a rush to appease the EU elite. There is no difference between the two fiats, except that Euro has a nominal gold reserve that is probably physically located in the central banks of all the EU members. Either the ECB monetizes all their dying sovereign debt or the PIGS will default. In either case, the Euro is toast.

The ECB will be buying this debt from TBTF banks and the central banks. I don't see how "gold backing", whatever that means, will maintain confidence in a governmental system that is totally corrupt and bloated beyond recognition. The Euro will die, because the Bismarkian social state is no longer sustainable with low birthrates and massive unfunded liabilities.

It is the usage demand which gives currency its function, not population growth. Is USD demand reliant on US population? What proportion of USD is actually inside the US? You get the point?

@ Pete,

Bear in mind that the ECB has floating gold reserves of substance. This makes a material difference to the Euro in comparison to all other currencies, and also gives them far more ability to "print" and "bail" than is immediately obvious. I believe FOFOA has more to say on this, using the angle of "hard" and "soft" money, which will clarify this situation.

@ Martijn,

I am simply using the FOA quote from this post in which he states:

"Somewhere in the 1970s era I was exposed to the thinking of several different deflationists..."

If he was exposed to this knowledge in the '70s, and wrote that statement around 2000, then he must have had 20+ years to consider these ideas, mustn't he? Granted, Another was possibly one of those from whom FOA learnt. I don't know.

@ Desperado,

As I mentioned to Pete, above, the ECB has an "Ace-in-the-Hole" in this regard. The gold reserves, hard (to get) money, floating in an ocean of their (easy to get, they can just print it up to bail things out) medium of exchange currency, the Euro.The Euro has already split the medium of transaction and the store of value functions! They are simply waiting for the rest of the world to realize that they need this split as well. Like good boy scouts, Europe is already prepared. As FOA pointed out, they have been planning this for several decades.

I imagine they are a few steps ahead of you and I in this regard, and figured out the answers to your "problems" many years ago.

I would like to make a few observations about the Euro. Please pardon any overlap with Angel Eyes' comments.

1. The EU "political hacks" don't control the Euro. I'm not suggesting that the ECB is immune from political influence but it has a high level of autonomy and a single mandate - currency stability.

2. The EMU countries have large gold reserves. When you look at their sovereign debt position you need to factor in the gold reserves. Debt restructuring is likely on the cards after recurrent spending is brought to a level that doesn't require further borrowing. There is no point in debt restructuring while a country has budget deficits funded by borrowing. If, say, Greece cannot achieve this the EMU has other options.

3. In order to succeed the Euro doesn't need to "replace" the US$ in most of the US dollar's current role. For example it wasn't designed to be the next single reserve currency. In order to offer an alternative to the US$ the Euro had to be accepted in transactions in Europe and in international trade. Mission accomplished.

4. IMHO the EU political elite will continue to attempt to bail out their banks. So the critical question is: How much currency issuance can the Euro withstand without failing?

I think the answer is "a lot" for a few reasons. A cheaper Euro = greater export competitiveness + increasing value for the EMU gold reserves. Reducing the US dollar's use in world trade also creates space for other currencies to expand into. The Euro is well placed to benefit from this.

As a Deflationist (caveat below), I find your article provoking, but I have some questions.

I have always understood what you call the 'political will' to save the debt based asset side of the balance sheet, and its implications. It is obvious that Bernanke, as he himself has threatened, 'could' bid that baloon to nearly 100% of its mark-to-fantasy. Thus, more correclty I'd label myself a 'Schrodinger's Cat Deflationist', since I exactly agree with the 'possibility' of the scenario you outine. But I do not agree that anything close to 100% of that asset baloon will be saved. (aside: also quality QE swapped assets is much more important than quantity) My guess is that Ben will hand pick the minimum amount of assets necessary to save in order to 'balance' things 'on the knife's edge' on a slow ride down toward a lost decade a la Japan. So...

Question: What drives your assumption that he will paper everything? Also, if hyperinflation is assets being papered over with base, what is your view of Japan in this context?

You paint a picture of base money not being able to 'contract along with the economy like credit money', but this is not true, at all (unless we are completely misunderstanding each other). The large amount of bank reserves sitting at the Fed right now will be vaporized in order to maintain capital ratios if further writedowns are incurred. In fact this is precicesly why they are probably just sitting there 'unemployed' collecting 0.25%

Question: Can you please clarify what you mean here (base inelasticity)?

I don't think Deflationists discount human emotion. Speaking only for myself, its quite the contrary. I just feel that the fear of "losing your job and running out of dollars" overwhelmingly trups even any consideration of currency devaluation, for 99% of people anyway. (Schrodinger's disclosure: I own PM's!) I'm intrigued by your description of hyperinflation as a loss of faith that preceeds the printing, but I can't find where you describe any mechanism that causes the sudden sea-change.

"The large amount of bank reserves sitting at the Fed right now will be vaporized in order to maintain capital ratios if further writedowns are incurred."

"Writedowns" occur on the asset side of a bank's balance sheet, not the liability side. The liability side is GUARANTEED not to shrink! Remember, the banks' liabilities are really just "the people's" digital money! Banks' "assets" are "the people's" debts. Those "excess reserves" may be reclassified as "bank assets" if further write downs are incurred in their present "assets," but they most certainly will not vaporize! They are base money owned by the banks right now. They are contractual obligations of the Fed to print cash for the banks (when necessary). They are assets of the banks!

They will become balance sheet "assets" to directly balance the "liabilities" (digital money) the bank has outstanding. In other words, base money to balance against the digital (illusion) money! This is the early process of hyperinflation... replacing "the people's" credit (digital) money with base money! Just wait. I'll give you more in part 2 of this post.

Sincerely,FOFOA

PS. If you think the Fed will balance things on a knife's edge you aren't much of a deflationist. You belong on CNBC!

"A couple of threads back you said that the Swiss Frank (might?) be the only fiat to survive. I would love to hear your thoughts on that score.

I think it was ANOTHER, not me. And I think he said that back when Switzerland was still on the gold standard, the BIS was still using the Swiss franc as its unit of account, and back before the Swiss politicians sold half the Swiss publicly-owned gold stockpile to raise some spending cash.

But don't get me wrong! I think you are in one of the best places to be today! And the Swiss franc will probably fare second best!

@Fofoa, RE: Swiss Franc. My impression is that Hildebrand and the SNB have already shown that they are subject to political pressure by intervening in the FX markets to try to devalue the Franc, and at one point in 2009, I believe the SNB intervened and purchased certain corporate bonds to support that market. I think the main advantage the Franc has over many currencies is that Switzerland has smaller government and up until now balanced budgets. The problem is that when the firestorm hits the dollar, Switzerland and the Franc will be put under enormous stresses, and I am not confident that the "welfare state" won't assert its control and monetize the failing assets of the big banks.

@Costada, Angel Eyes, RE: the Euro.

If one assumes that the ECB gold reserves are physically located in each EMU member's CB, then they cannot really be counted as Euro reserves. Said gold could be considered to be "politically encumbered". My guess is that those EMU members would have been rather leery of shipping all their nations gold to the ECB headquarters in Frankfurt. There are still a lot of bitter memories concerning Germany's seizing of gold during WWII.

And what exactly is "gold backing" of a currency anyway? Sure, if the price of gold rises as quickly has the value of a "gold backed" currency deflates, then I guess that would add some "confidence". But it is all a confidence game anyway, and I really doubt that the Germans or Austrians have any confidence in the socialist governments of the PIIGS. And the longer these countries continue deficit spending (with increasing deficits to boot) without any viable plan on how to pare back their irrefutable entitlement obligations and their crushing demographics, then the less confidence Eurozone citizens will have in the Euro. The Euro, like the dollar, is crumbling before our eyes, and there is no political will to take the bull by the horns and deal with it.

All that ECB gold is like the gold in Fort Knox: Rumors of it's existence will not restore confidence in the currency, but any evidence of the non-existence of that gold will crush confidence. And even if they manage to quash any rumors of lack of CB gold, the never ending drip of bad deficit news will keep on getting worse until some TBTF bank or country somewhere, finally collapses, and then the house of cards will collapse. And when that happens you can be certain that Euro will not be left standing.

The Japanese case is interesting in this respect, however it is often referred to without much context.

Japan for instance had a massive asset bubble before the so called 'lost decade', which basically was a correction of the previous bubble.

Also prices of necessities (food and the like) did hardly deflate at all, the deflation was mostly in - financed - asset classes such as houses and stocks.

Besides the Yen has not been world reserve currency and Japan has helped in supporting the USD.

Comparing both one-to-one leaves many important differences out of the question, and the assumption that Japan was unhappy with the deflation and 'trying like crazy' to prevent it has yet to be proved in my opinion.

But it is all a confidence game anyway, and I really doubt that the Germans or Austrians have any confidence in the socialist governments of the PIIGS. And the longer these countries continue deficit spending (with increasing deficits to boot) without any viable plan on how to pare back their irrefutable entitlement obligations and their crushing demographics, then the less confidence Eurozone citizens will have in the Euro.

Perhaps so, perhaps not. It is questionable how well Germany would be off when standing alone against huge China (and the US).

Also, that very same (if not worse) deficit spending of the US did not matter at all for the trust in its currency (the USD) over the past decades. Off course that is different with the non-reserve Euro, but still.

The Euro, like the dollar, is crumbling before our eyes, and there is no political will to take the bull by the horns and deal with it.

Perhaps the Euro is returning to what it is: fiat money for the trade of things, not a medium for long term storage of wealth.

Along with the return of the Euro to its roots, gold does the same, leaving a perhaps a more balanced financial spectrum?

"but I do believe there is slight different between the CB and the private market."

If the CB gold is encumbered by multiple, conflicting claims, then it will be the same as whatever Comex and LMBA gold remains after the top finally blows. It will all be tied up legally in court. What about the 340 tons of BIS swapped gold from July, how many conflicting claims are there on that? What about owners of sovereign debt if there is a default, do they have a claim on the CB gold?

"It is questionable how well Germany would be off when standing alone against huge China (and the US)."

The RE collapse, the coming Fiat collapse, the bank bailouts, etc are all symptoms of a bigger problems, the "welfare state" bubble. What might have been sustainable when started by Bismark if it had been responsibly managed, has been abused and continually extended by irresponsible politicians the world over.

The end of many of the western "entitlements" is going to cause severe social problems in Europe, and the Euro will not stand. I doubt that open borders will, either, at least between regions. The Germans will not trust the EU and will look out for themselves.

In relation to the ECB gold holdings I understand that the initial 15% of reserves in physical gold was transferred to the ECB. The overall gold reserves of the Eurosystem (EMU) Central Banks includes the ECB gold reserves in the total.

The individual EMU Central Bank holdings are important from a sovereign debt perspective but not from a Euro currency perspective. The ECB gold reserves support the solvency of the ECB as issuer of the Euro currency.

In other words the gold reserves of each of these actors serve some common interests and certain national interests which need to be analysed separately.

I don't understand why you seem to equate the prospect of social unrest in the EU with the demise of the Euro currency. IMO the revaluation of the EMU members' gold reserves will inspire high demand for their sovereign debt PROVIDED they reign in their deficits and cease to borrow for recurrent expenditure.

I fully anticipate some major upheavals globally but IMO there is no certainty that any other currency will fail except the US$. Why single out the Euro? Do you see the break up of the EMU as a given? If so, why?

(FOA speaking with Michael Kosares: MK: In the Robert Mundell speech for which Steve H provided a link, the laureate said as early as 1997 there would be a new gold market and that central banks would look to settling with gold at free market prices. He suggested that this would occur in the 21st century....

FOA: ....Boy,,,, Michael, I have to tell you, Mundell knew the story and no one listened! Now the whole Dollar/IMF system is in change and most of the nonEURO US trade partners have bet their entire economic society on a prosperous, buying American public. The next few years will be history to remember.(smile) )

-----------TOKYO, Oct 27 AFP - Investors scurried to snap up the yen today on news that Japanese authorities may upgrade an official forecast ---------

Hello Steve,Don't know how many people have called for a weaker Yen over the last few months. Yet it still goes up. Even Dennis Gartman in this weeks Barrons is looking for the Yen to fall. I understood years ago that their economy is so tied to the US that their currency would lead them into a depression prior to the dollar falling away. Truly, their financial / economic system is so manipulated it makes our gold market look "Free"! Any country that can take it's rates down to 1/2% (or 0%) and still have a strong currency, is going to go into a major downturn. Usually a nation could inflate their way out of it and bring on a falling currency. Yet, their system is radically different as it was / is built as a suburb of the US. Any upturn brings then a higher Yen that chokes them back down. This very dynamic is the poison that is killing the Yen carry trade and by association is forcing the same funds to cover their gold carry. It's been going on from the summer and has accelerated after the Washington Agreement! All and all, another reason why the Yen will not be allowed to spear head a new pacific currency unit. I look for China to side with the Euroland system before it's all over. Let's watch this action play havoc with the US marketplace (not to mention the gold price).

- Angel mentions "Usage demand", How will the world come into confidence of a EUR currency. I guess it will be based on holding value and not dilutable, exchangeable for Gold etc, which implies a healthy economy for the next 50 years. If we think that European population decrease by 2% every year(74% popl reduction), How are entitlements for various ponzi schemes(pensions...)going to financed without dilution. So before EUR becomes store of wealth the demographic Question does come into play. Negative Demographics destroys all the ponzi schemes(real estate, pension, coupon payment....)

- If such a poluation reduction happens, How would other Govts store EUR denomination Long Bonds. If EUR issues 100 year bonds, would anyone buy that with a negative population.

Of course I am a little exaggerating population reduction, but it is virtually impossible for a negative population to issue world reserve currency. Irrespective of how much Gold they have. Who can guarantee no dilution ?

Why is it that y'all would insist on possession of physical gold over paper/ETF gold privately, and yet insist that paper gold reserves for sovereign paper, or as Angel Eyes says, "the ECB has an "Ace-in-the-Hole" in this regard. The gold reserves, hard (to get) money, floating in an ocean of their (easy to get, they can just print it up to bail things out) medium of exchange currency, the Euro.", is sufficient for currency "backing"?

If the transactional aspect of the currency can be separated from the store of wealth aspect of the currency, then why does the Euro even need the gold backing? Perhaps due to the internal conflicts and instabilities of a continent that has been at war with itself for multiple millennia? And 15% "reserves", what is that? If GLD promised 15% reserves, would that instill trust in it?

But lets face it, the bottom line is that you guys seem to think that the EU and the Euro are worth saving. I think that the EU is no better and probably worse than the US federal government. Perhaps it is wishful thinking, but I am very skeptical that the Euro ruling class will be able to keep on inflating their welfare bubble after the US federal government and the dollar collapse.

Costada says: "IMO the revaluation of the EMU members' gold reserves will inspire high demand for their sovereign debt PROVIDED they reign in their deficits and cease to borrow for recurrent expenditure. ". All I can say is that as long as the socialists have any credibility in any European country, I will not purchase their debt, and I really don't care how much gold backing they claim to have. It really is as Fofoa has said, the politicians are completely corrupt and cannot be trusted to make any decisions that don't personally benefit them. And besides, after the fall of the Berlin wall we saw how all the ex-communists simply became greens, socialists, and rich "capitalist" plant-owning parasites instead of communist parasites. Well until the parasites have been completely eliminated, the host cannot recover.

And it is on this score that the outlook for Europe is decidedly worse than for the US, where at least there is a tea-party, a second amendment, right wing talk radio, conservative blogs, and a strong vein of independence and individual rights. In Europe, even in Switzerland, the citizenry is completely oblivious to the freedoms that are being stolen daily, let alone how long the path back to freedom is. Perhaps this is because Europe never really experienced freedom as America did. They went directly from the class system to socialism without ever being free.

FOFOA is right, base money will be in more than compensate of assets money losses.

Bank has $1000 asset money, $100 base money(10% ratio). Their liabilites cannot go down or written off, they are FDIC insured.

Assume that Banks suffered a 50% loss on their Asset side ($1000), and they get base money for the loss - $500. Now their base money is $600 and asset is $500. Now they can create credit money for extra $5000. ie total credit money will now be $6000. ie 6 fold more money. This will be the fuel FOFOA is talking.

The real issue here is confidence, and I just don't think that EMU citizens will have any more confidence in the Euro than US citizens will in the dollar in the face of massive over-indebtedness, ever increasing deficits and a complete lack of integrity of the political class. The EMU also has a long history of cultural and national conflicts and enmities.

confidence in using it (medium of exchange) or saving (store of value) it?

the USD plays the role of both. in fact the definition of money suits the USD but unfortunately it doesn't do the store of value role very well. thats the fatal flaw in the definition of money imo.

the euro based on its balance sheet and design plays only the function role. they save their reserves most in gold where as the USD doesn't. in fact the ecb hasn't increased its foreign currencies for internal reserves at all since it started.

thats why everyone will feel confident in using the Euro because they acknowledge gold where as the USD competes against it and has tried to play role of store of value along with it.

the people will have the choice of storing their past labor in gold rather then in a medium of exchange like today that can always be diluted or in the bond market etc....

like today people can store their labour in anything. real estate, stocks etc... but they are all rigged beyond belief especially anything paper wealth related. do the arab's store their oil exchange in stocks or gold.

it doesn't matter what is used as a medium of exchange. all that matters is confidence in the storage of value imo.

i could care less if we used special kinds of rocks as the medium of exchange, i just need a place to store my work, something that can't be diluted, doesn't change hands often and is valued by everyone. this is what the euro is all about.

this is why the ECB have sold more gold since they started the euro in 99, so everyone can be involved in the transition. this is what angel eyes tried to point out.its your fault for relying on the government. rely on gold, they have been trying to get their citizens to do so for a while. look at china's gov.

FOAGold, from times past was a wealth asset more so than it was in the form of money. Granted, it became the fastest moving form of wealth, but as it traveled on the road it was still simply seen as a tradable wealth. It has been American and Western ideals that made gold a lend able money and forced its competition against failed currency systems. We set currencies in fixed gold amounts and then inflated the currency. No wonder gold competed against currencies. The ECB will allow gold to go to the moon and everyone will love them for it. People will use the Euro whether gold is at 1 Euro or a trillion.

I do think you are thinking about the way fractional reserve banking slightly wrong (see below). I don't know yet whether I am in complete disagreement with FOFOA or not (I'm awaiting his follow up post for clarifications).

Banks are not so much contrained in their ability to lend by their reserve requirements so much as they are by their capital. Its best to just think of banks as being not reserve constrained at all. As an aside, some countries are on reserve systems lower than U.S. Australia for instance is effectively on a 0% reserve system, but I digress. So long as credit conditions are favorable, and the bank figures it can profit, its lending desk approves loans first without 'checking' if they have enough reserves to back the loan. Banks extend the loans first, and seek required reserves after the fact. They can borrow these from other banks (interbank lending rate), borrow from the Fed (discount window rate), liquidate some assets, etc. So long as the spread between the rate they'd have to pay to borrow some reserves and what they're passing on to the consumer is profitable, they loan.

The key issue to look at is capitalization and the balance sheet. Capital is assets minus liabilities; the net must be positive. Credit-money that the bank lends to you is its liability, and your promise repay it in full (plus interest) is its asset. They balance. If a bank, per your example, takes a massive 50% loss to its asset side, it is severely out of balance and it needs to repair (i.e. get more assets). If that gaping hole on the asset side is patched up with a 'gift' of reserves, the bank cannot just go out and fractionally lend out all of 10x of it. It needs to repair its asset side first! Essentially the bank would turn around and purchase a 'good' asset with the gift from the Fed.

That is what is important to understand: all quantitative easing (QE) is, is the fed 'swapping assets' with a bank, usually reserve balances for bonds, treasury secs, etc. Typically the assets the Fed buys from the banks are very high quality. If the Fed buys extremely toxic quality assets, yes, this is essentially a fiscal 'transfer' to the banks. It will not however, result in an explosion of lending. Continue to witness this scenario play out.

One more QE note. As detailed above, QE is normally just swapping extremely high val assets. But IF the Fed starts mass purchasing junk assets which should otherwise be taking losses, then yes, ther will be 'problems' here. I just disagree with FOFOA in both the 'quality' and 'quantity' of assets purchases that will ensue. FOFOA seems to imply that 'everything' will be papered over. I could not disagree more. Additionally, and more importantly, consideration must be taken to 'what' the Fed is buying more than 'how much'. I did not want to get too much into this argument until I see his follow up post. See you then.

Hyperinflation appears concurrent with the DISAPPEARANCE of lending, not the explosion of lending. Inflation can be described as an explosion in lending, but not hyperinflation. Hyperinflation comes from the collapse of confidence in the currency. Prices of necessities rise as a result of the collapse of confidence at the same time as the price of collateral backing the banks' assets falls. The disappearing credit is replaced with base money to keep the banks in balance and that base money then leaves the corral (not through fractional reserve lending, but through direct circulation) and takes off in velocity just as the demand for dollars to service debt (credit) disappears.

A rise in velocity is concurrent with lower usage demand because of less lending. And a rise in velocity has the same effect on the purchasing power of a dollar (it lowers it) as an increase in quantity of dollars. So the purchasing power of the dollar starts falling BEFORE more are created. In fact it falls concurrent with falling broad money measurements! This is another thing deflationists can't wrap their head around. This fall in dollar purchasing power (against necessities only) spawns the NEED for the government to directly fund itself through the Fed.

Buck, everything will be papered over out of necessity after the fire starts. It is already happening and will continue until the dollar is worthless. But you are looking for the massive printing to spark hyperinflation, just like I said in my post that deflationists commonly do. You think, "if the Fed doesn't paper over everything then hyperinflation will never start and we'll have deflation, a rise in the value of dollars." But as more pain presents itself (with a rising dollar), more and more things will be papered over. Deflationists like you simply cannot believe this. But it was never in question. It is built into the system and guaranteed by political will. I think you are proving my post, at least the part about how deflationists think.

I have no problem with all that banking minutiae you learned from Steve Keen and the MMT crusaders, only with the conclusions that are drawn from it. You are still missing the big picture. The rules are always changed concurrent with any political pain, and this makes dollar hyperinflation the unavoidable end this time.

- The balance sheet of the FED reserve now has a lot of MBS backed by home loans. In fact the majority which are toxic assets. Hence I was saying that they gave credited reserves for those toxic assets at par value. FED has not fully disclosed but the FED balance sheet is showing that the bank reserves are approx $2.2 Trillion and most of the assets are MBS toxic assets.

- The Reserves are just sitting there getting 0.25% interest which are waiting to be lent out.

- You maybe right that in some countries like Australia they operate at 0% Reserve but if they have severe capital requirement who will lend to them short term and if they have bank run. Their CB will have to step in and rescue them and mark down the loans and arrange buyout to some other Bank but the Loan losses will have to payed to new Bank takeover samilar as FED did in 2008/2009.

- you say "Hyperinflation appears concurrent with the DISAPPEARANCE of lending".

- Why would banks not lend since their liability is also in Dollars, Unless NO ONE will sell any assets for Dollars. Yes you could be right, No one wants dollars, the Interbank lending rate should Plunge and No one wants loan also because no one will sell anything for dollar.

- Then the interest rates should also plunge ???? Interesting... Then the Banks are totally short circuited and no one needs them.

- How will Govt then finance itself for the liabilities ? It will be pure catastrophe...scary indeed if it happens.

"base money then leaves the corral (not through fractional reserve lending, but through direct circulation) and takes off in velocity just as the demand for dollars to service debt (credit) disappears."

Hmm... I had to imagine myself as someone who lost confidence in currency and play out the scenarios to see your view point.

You refuse to answer my very basic questions (see initial comment). As such, I cannot get a grasp on ‘why’ you make your grand assumptions and leaping conclusions as to the ‘guaranteed’ trends of herd behavior, Fed actions, political will, and their resultant outcomes. Fair enough. It’s your forum.

However, what I can say is that claiming to understand how I think does not do much to inflate your credibility as one with a nuanced understanding of the world. As I took great pains to make clear to you, I am ‘hedged’. This is because I do not claim to have omniscient foresight of future events, let alone the thoughts of others, as do you.

When I call myself a ‘Deflationist’, I use my conservative definition of it, which is merely someone who thinks such an outcome is ‘more likely’ than others. I don’t claim or even believe the outcome is ‘unavoidable’ or that the Fed’s moves are predetermined. Perhaps this sort of mentality is difficult if not impossible for a crusader to understand. But alas, I’ll admit it: I am human with imperfect knowledge of the world.

Given your intimate familiarity with all the minutiae of ‘the big picture’,’ guaranteed political will’, ‘baked into the cake’ monetary policy and everything else that escapes most, perhaps your talents would be better suited in a field like asset management, political office, public relations, sooth-saying, or anything else other than blogging. (Sorry, just my little attempt at predicting the future.)

Congratulations! You have correctly identified the reason I started blogging: To draw attention to the TWO (count em: only 2) things that are actually "baked into the cake!" Those two things are: (primarily) FREEGOLD, (and secondarily) HYPERINFLATION. That's why I'm blogging.

I have spent much time on this blog in my 265 posts and thousands of comments explaining how I view the world in a "probabilistic way." I view it as a grand poker game. The probabilities say one thing, and the cards often deliver a different verdict. But from day 1, the reason I started this blog, and it has never changed, is that Freegold and Hyperinflation are how this thing ends. Timing doesn't matter because you can't be too early to these two events. And yes, they are separate events.

If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

The September 13th metal value of these nickels is “$0.0574114” or 114.82% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” available at Coinflation.com.

I come here as an MMT Proselyte so I guess that makes me a deflationista. You make a persuasive argument particularly because you are the first hyperinflationist that Ive read that admits that the money printing is not a cause but an affect. I do think this is an important point because hyperinflation is a result of real prices rising due to a severe supply contraction. Weimar Germany and Zimbabwe are classic examples of this and your argument that the American hyperinflation would be due to the deflation killing all economic activity with the likely response being for the monetary authorities to print money til the cows come home.

I've actually considered that scenario myself but I do wonder why that didnt happen during the Great Depression. Why didnt we see the hyperinflation then? Economic activity was much lower than today, largely because many people had no safety nets. The worldwide affects were much more profound as well werent they? Considering the state of many of the smaller economies of that day.

I do wonder how Bill Mitchell, Randall Wray, Warren Mosler or Marshall Auerback would respond to this argument of yours.

It does also occur to me that if we after the severe deflation simply became more parochial and took care of our own if we might not avoid the hyperinflation. We HAVE the capacity, like only a few nations do to produce everything we need right here. We can also keep the demand for dollars high domestically with taxation. In a pickle it matters not if any foreigners want our currency. We can just use it ourselves.

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